A Guide to Understanding Your Credit

Make sure your credit rating doesn't hurt your future
January 07, 2013

Understand the Rules

Credit can be enormously convenient, but it can also be a dangerous temptation. Not understanding the rules of credit can affect your future ability to receive aid for things like a college education or a new car.

Your credit rating is one of the most important things you have and you are in complete control of it. It is up to you how good or how bad of a credit risk you will be.

Why Having Good Credit Matters

Imagine this... You have just graduated from high school and are ready to tackle the world. You have found the perfect apartment and the perfect roommate. The apartment manager says they will need to do a credit check first because you have not established rental history. The next day you find out you have been declined because you haven't paid your department store bill on time. By not making your payments on time you have blemished your credit history and made yourself risky to lenders and apartment managers.

Having good credit is one of the best ways to prove to lenders that you are trustworthy. If you ever want to purchase anything on credit, whether it is a new car, an education, or a house, having a good credit rating can help.

Terminology Associated with Credit

Annual Percentage Rate (APR) - Percentage of interest charged to purchases on a yearly basis.

Cash Advance - Borrowing from your credit card for cash up front.

Credit Bureau - Agency that reports your credit history to lenders. (Trans-Union, Equifax, Experian)

Credit Limit - Maximum amount you can charge on your card, including cash advances.

Fair Credit Reporting Act - If you are denied credit due to something on your credit report, the lender must identify the credit bureau involved. Upon your request, you are entitled to a free copy of your credit report from that bureau within 30 days.

Finance Charge - The total dollar amount you pay to use credit.

Grace Period - Amount of time given by a creditor where no interest or finance charges will accumulate, provided you pay off your purchase before the period ends.

Minimum Payment - Percentage of your outstanding balance that must be paid each billing period.

Payment Holiday - Billing period where no payment is due. Finance charges and interest will still accumulate on unpaid balances. Usually a reward for good payment habits.

Tips for Keeping Your Credit History Clean

Always make your payment on time.
Being late just once can lead to a bad habit of being late every time, resulting in a blemished credit rating and decreasing your chances of being approved for educational loans or car and home loans in the future. Late payments may also increase your interest rates.

Never spend more money than you have.
If you don’t have the cash to pay for it now, you will probably not have the cash to pay for it later when the bill is due.

Limit yourself to one credit card only!
Having more than one card creates temptation to spend more money you don’t have. Never carry a credit card unless you plan to use it–it only invites temptation.

Try to make more than the minimum payment due.
Interest rates apply to any balances carried over, so your minimum payment may not be paying for your purchase, instead it’s going directly to the credit card company as interest. It takes longer to pay off larger balances, increasing the amount you pay in interest charges over time.

Apply for student credit cards.
Student credit cards may have lower credit limits, reducing the temptation to charge large amounts. These cards establish credit in your name and provide the opportunity to build a good credit history from the beginning.

Types of Credit

Bank-issued credit cards are issued by a financial institution. Visa and MasterCard are the most popular forms of this type of credit. Interest rates and spending limits vary depending on credit history and personal income.

Secured credit cards are issued with a preset limit usually based upon an amount of cash in an established savings account. This "secure" form of credit guarantees the bank you will pay back the amount borrowed, and if you default there is a form of collateral to collect from. This is a safe way to establish a good credit history if you have never had a credit card before.

Retail store credit cards are issued by a retail outlet and can only be used for purchases within a particular store or chain of stores. Interest rates are generally the highest of all types of credit. Spending limits vary depending on spending habits, income, and credit history.

A loan is one large lump sum cash payment granted by a financial institution for purchase of major or large ticket items. Interest rates and amounts vary depending on the type of loan and credit history. Some examples of loans are new or used car loans, educational loans, and home mortgage loans.